How to exercise caution when investing in digital currencies

Canadians are increasingly moving away from traditional investments and exploring digital currencies such as Bitcoin, Ethereum, Dogecoin, and others in an increasingly volatile market environment. However, significant risks come with the rapid growth of the digital currency market — and it is crucial to navigate them carefully.

Let’s discuss the risks involved with these relatively new and extremely accessible assets so that you can understand how to mitigate them and make informed decisions.

Instability

Digital currencies are notably unstable. Prices can fluctuate wildly in a short period, as seen with Bitcoin’s meteoric rise and sudden crashes over the past decade. While this volatility can present lucrative opportunities, it also carries the potential for substantial losses.

Risk mitigation strategy

It is essential to assess your risk tolerance and financial goals before diving into the digital currency market. Cryptocurrencies should not make up the bulk of an investment portfolio — and you should be prepared to lose what you invest. If you are considering investing in a digital currency, treat it as a high-risk, speculative investment and ensure it doesn’t jeopardize your overall financial health.

Security risks and scams

The decentralized nature of digital currencies means that transactions are peer-to-peer — without the oversight of a central authority like a bank. While this offers increased privacy and security, it also opens the door to a variety of scams and cyberattacks.

Canadians reported losses in the millions due to cryptocurrency fraud. Our Licensed Insolvency Trustees (LITs) have seen numerous insolvency filings from individuals who were taken advantage of through crypto scams.

Risk mitigation strategy

Click here to learn how to identify the warning signs of a crypto scam before you invest. Common schemes include Ponzi schemes, pump-and-dump schemes, phishing attacks, and fake exchanges. It is vital to exercise extreme caution when engaging with any cryptocurrency platform, exchange, or individual.

The cryptocurrency space is largely unregulated in Canada, leaving investors with little recourse if something goes wrong. Always verify the legitimacy of the platform and never share your private keys or information with anyone.

Legal and tax considerations

While cryptocurrency is not considered legal tender in Canada, it is treated as a commodity by the Canada Revenue Agency (CRA). This means that any profit made from trading or investing in digital currencies is subject to taxation — either as capital gains or business income, depending on the nature of your activities.

Risk mitigation strategy

Canadians should maintain accurate records of their transactions for tax purposes and be aware that tax laws related to cryptocurrency are constantly evolving. Failing to report cryptocurrency income or transactions to the CRA can lead to penalties and interest charges. Consulting with a tax advisor who understands cryptocurrency is advisable to ensure compliance. If you find yourself with an unexpected or unaffordable tax plan, reach out to an LIT to understand your options.

Loss of access

One of the biggest risks with digital currencies is losing access to your funds. Cryptocurrencies are stored in digital wallets, which are protected by private keys. There is no central authority to help recover your funds if you lose this key, or if it is stolen or compromised. Cryptocurrencies do not offer customer service or account recovery mechanisms, unlike traditional banking systems.

Risk mitigation strategy

Take extra precautions to secure your private key, such as using hardware wallets or multi-signature wallets. Backing up important information and maintain a secure, offline storage system or keys is critical to minimize the risk of losing access. It is also crucial to ensure that you properly wipe external hard drives before disposal.

While the Canada Deposit Insurance Corporation (CDIC) provides protection for bank accounts, there is no insurance for digital currency holdings in Canada. This lack of oversight means you may not be able to recover your assets if a platform is hacked or goes bankrupt. It is vital to use reputable and well-established exchanges and avoid investing more than you can afford to lose to reduce the risk of encountering this issue.

Regulatory landscape in Canada

While Canada has a relatively progressive stance on digital currencies, the regulatory landscape is still evolving. The Canadian government introduced new measures aimed at preventing money laundering and providing clarity around the taxation of cryptocurrency in 2023. However, cryptocurrencies are still not fully regulated, and this can expose investors to heightened risks.

Risk mitigation strategy

It is important to stay aware of the latest regulatory changes, as the Canadian government may introduce additional rules or restrictions that impact digital currency holdings. Keeping informed about these changes can help ensure that you comply with Canadian law and minimize your exposure to risks. It may be helpful to speak with an advisor to understand recent updates or changes to the law.

Digital currency treatment in insolvency

Digital or cryptocurrency is considered a non-exempt asset in Canadian insolvency filings. This means digital currencies are available to creditors and susceptible to creditor action if no formal protection is in place.

Risk mitigation strategy

If you have digital assets, you may be able to keep them through a Consumer Proposal or through a repurchase agreement with an LIT. If you are considering a debt solution and have these kinds of assets, it is important to reach out to an LIT to review your options.

Take control of your financial future

While digital currencies offer many opportunities for Canadians, they also carry numerous risks. The volatile nature of the market, the potential for scams, and lack of regulatory oversight can make the digital currency space a challenging space to navigate. It is crucial to understand the risks and know how to manage them to maintain your financial security.

If you or someone you know has been a victim of a crypto scam and are no longer able to manage debt repayments, reach out to a local MNP LIT. We can help you understand all your debt relief options so you can choose the one that works best for your unique situation. Together, we can help you achieve a fresh financial start.